America's biggest bond buyers aren't buying bonds
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Behind the surge in U.S. government bond yields over the last six months is a simple fact: China and the Fed — long the two biggest single players in the market — aren't buying.
Why it matters: In recent decades, the two acquired trillions of dollars worth of U.S. Treasury bonds, financing the big deficits that emerged after the financial crisis of 2008 and the COVID pandemic.
State of play: That's changed. Over the last year, the Federal Reserve has decreased its holdings of U.S. Treasury bonds by $650 billion.
- Public data on China's official holdings show them down by more than $50 billion over the same period, and they're down nearly $300 billion since early 2021.
Context: The Fed isn't actually selling U.S. Treasuries — it's letting them mature and "roll off the balance sheet" instead of rolling into new bonds.
- Also, there are big limitations to the publicly available data on China's holdings. Some experts, like Brad Setser of the Council on Foreign Relations, think China's holdings are more or less flat, rather than down — but that some of the bonds are stashed in places that don't show up in official data.
The big picture: That said, the fact remains that neither the Fed nor China are the big buyers they once were. Here's why.
Flashback: The Fed began buying long-term Treasuries in the aftermath of the 2008 financial crisis, as a way of trying to inject cash into the U.S. economy, reinvigorate growth and inflation, and lower unemployment. (This was called quantitative easing.)
- China became a major buyer of U.S. government bonds about 20 years ago. As its economy boomed, it used Treasury purchases as a tool to help keep its currency from strengthening, helping to boost its exports. (Read more.)
Yes, but: Today, things are different.
- In the U.S., unemployment is low and inflation has been a problem, so the Fed is siphoning out some fuel it previously pumped into the economic engine, by shrinking its holdings of government bonds. (This is called quantitative tightening.)
- In China, the economy — and the currency — are weakening. It now may even be selling some of its Treasuries as it tries to support its slumping currency.
- Further, the worsening relationship between the U.S. and China — as well as America's sanctions on Russia after its invasion of Ukraine — might be giving Beijing a reason to reduce its exposure to the U.S. financial system.
Between the lines: It wasn't just their size that made the Fed and China important to the Treasury market. In market jargon, they were "non-economic" or "price insensitive" purchasers.
- That means they weren't just investors looking at Treasury yields and thinking they were a good place to earn returns — rather, they were using the Treasury market as a tool to accomplish policy goals.
- So even when yields were insanely low, they were still buyers. That is a pretty handy investor base for an indebted country like the U.S.
The bottom line: Without these two seemingly bottomless sources of demand for American bonds, Uncle Sam has to offer higher yields than it otherwise would have, to get the money it needs from investors.
- Of course, the disappearance of bids from the Fed and the Chinese buyers isn't the only factor behind the recent rise in bond yields, which also reflects a supply onslaught and market views about economic growth, inflation and Fed policy.
- But all of these factors clearly point to a higher-for-longer reality, which will make U.S. debt, now at almost 100% of GDP, tougher to manage.
